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Deconstructing Debt Head

Mitch Bonilla is deploying one of the most exotic, sophisticated
kinds of technology available today to tackle one of humankind's
oldest tasks: bill collecting.

Bonilla and his San Diego-based company, ContiAsset Receivables
Management, are using neural network software to better understand
the people who fall behind in their bills-and to help identify
which ones will ultimately pay up.

Neural networks are computer programs that actually "learn" from
their experience performing a particular task, and then get better
at it, like IBM's Deep Blue, by identifying significant patterns
and aberrations. The programs are used for a wide variety of
complicated jobs, from managing power plants and understanding
traffic jams to doing medical diagnosis and detecting fraud in
financial transactions.

Bonilla just wants a little help figuring out which of his
delinquent credit card customers will ultimately pay their bills in
full, which ones will only pay 50 cents on the dollar, and which
ones will tell him to get lost. The neural network his company has
designed takes data about customers from several different sources
and searches for patterns that will predict how various groups of
delinquent debtors are likely to behave. Bonilla would, of course,
much rather call on the full-pay customers first. "We're in the
developing stage now," he admits. "It's a little fragmented, but
even in fragmented pieces, it's working pretty well."

ContiAsset is one of a handful of companies nationwide pushing
into a new frontier in financial services: studying the
demographics and psychographics of delinquent debtors so that
creditors can tailor their collection approach. The company is
looking for signals about payment behavior based on its customers'
current situation-their present income and how they're dealing with
other creditors.

Other financial services companies are trying to understand
whether the circumstances that caused people to fall behind on
their bills can be used to predict if they will ultimately pay
those bills. Do divorced people need different incentives than
those who have been widowed? Do kids fresh out of college who max
out their cards with furniture and bar bills respond differently
than people who were unemployed for nine months and used credit to
buy milk and bread? Who struggles to pay, and why?

Tulsa-based Consumer Financial Services, which owns $15 billion
in charged-off credit, has been the giant within the group of
companies that buy delinquent debt from credit card companies for a
substantial discount, then work to collect that debt. CFS, which
stumbled this fall amid allegations of irregularities involving its
financing, is nonetheless a pioneer in studying delinquent debtors.
This summer, the company went so far as to hire a full-time
clinical psychologist to help it learn more about its customers,
luring John Bachman from private practice in Menlo Park,
California.

Demographic analysis has been common for years, if not decades,
among companies that offer credit-using sophisticated formulas to
figure out who to offer credit cards to. But even the credit card
companies haven't expended much energy trying to understand why
people stop paying their bills, and how best to persuade them to
resume paying.

"What we would like," says Wayne Learned, operations manager of
CFS, "is to be able to say about a customer, 'This is a WASP from
Minnesota who subscribes to these three magazines, attends this
kind of church, has this socioeconomic status,'" and got into
financial trouble because of, say, a divorce. "So when we contact
him, our computer [will] say, 'This is who he is and this is the
available employee who is the closest match, in terms of
demographics and psychological profile.'"

Two things are surprising about these efforts. One is that they
reveal how little financial services companies often know about
their customers. The other is how revealing, and how powerful, even
a little bit more information will be.

"We don't know where this is going to end up," says Learned.
"We're just dreaming this stuff."

More than ever, this is the season of consumer debt, and not
only because December is the month Americans traditionally buy
things they pay for come spring. In 1997, there were 1.3 million
personal bankruptcy filings-an all-time record-up 20 percent from
1996 filings, which were 29 percent above 1995. Those three years
alone account for more bankruptcies than were filed during the
entire 1970s. At the end of July 1998, Americans owed $1.266
trillion in nonmortgage debt-a number that has ballooned 66 percent
since the roaring 1980s and now equals roughly $5,000 in debt for
every man, woman, and child in the nation.

Of course, most people pay their bills. But the ones who can't
keep up are a huge business in the United States. Credit card
companies alone charge off $22 billion a year in unpaid bills-$60
million a day. The 1.6 million families who voluntarily sought
counseling for financial problems in 1997 with affiliates of the
National Foundation for Consumer Credit, a nonprofit association of
credit counseling agencies, together claimed delinquent debts
totaling $35 billion-and they make up less than 2 percent of all
U.S. households. (The percent of bank credit cards with past-due
balances has ping-ponged up and down over the last decade between
2.5 percent and 5.6 percent, but the size of the total debt, and
thus the mass of the delinquent debt, has grown steadily.)

Despite the amount of money involved, almost nothing is known
about these delinquent debtors. People who pay their bills on time
are not lenders' profitable customers, while people who go bankrupt
turn the profit equation inside out. It is the people in the
middle, those who fall behind but are determined to make good, who
can generate the best return for credit companies. "That one sector
should be of interest to creditors," says Mac McCarty, an analyst
for Trajecta, an Austin, Texas, consulting company that develops
tools for assessing risk in financial portfolios.

Trajecta has begun to work with some clients, including credit
issuers and financial services clients, to understand delinquent
debtors better. "With the market saturated, with banks having
issued all the credit cards they can issue, people are saying,
'Hey, let's look at the back end of this process, let's learn to
collect better,'" says Matt Harris, vice president of analytical
services at Trajecta.

Among the early users of such techniques are a few of the credit
card issuers themselves. Banks and card issuers have traditionally
written off their delinquent accounts after six months, and sold
them at a steep discount-a dime on the dollar, or less-at the time
of write-off. For some banks, that's changing. They still write the
debts off, as required by banking regulations, but they are
choosing some of the delinquent accounts to work themselves.
Lenders are reluctant to discuss how they handle delinquent
customers, for reasons of competition and customer sensitivity.

ContiAsset's Bonilla, who buys the bad debt from banks,
attributes his idea to do more analytical work on delinquency to
the credit card companies themselves. "I know of at least three
[credit card companies] who are identifying the accounts most
likely to pay and sending them to their own collection agencies.
They are identifying the accounts least likely to pay, and those
are the ones they are going to market with."

And what does determine whether someone digs out of debt or goes
bankrupt? Does the original source of the debt matter? Does it
matter if some one-time event-like a temporary layoff-causes
someone to fall behind? If someone has never been delinquent
before, is there anything in his history that helps predict whether
he'll catch up?

"The short answer is, nobody's got the data," says Jesse Snyder,
managing editor of Collections & Credit Risk magazine. The
application of the kind of demographic, statistical, and
algorithmic energy that is common elsewhere-from understanding how
often to send someone a mail-order catalog to deciding whether to
offer credit in the first place-is only now being applied to
delinquent debtors.

"I was talking to a credit-card company official the other day,"
says Leigh Smith, of SMR Research in Hackettstown, New Jersey,
which does research on consumer credit. "And he said to me, 'The
difference between our most profitable customer and the delinquent
customer is not that big, demographically. Age, income, debt
outstanding, they are all very similar.'"

Of course, there is all the difference in the world between the
best customer and the charge-off customer: It's the difference
between the person who has the wherewithal to pay his bills and the
person who doesn't. The question is whether that difference can be
quantified.

"We call it 'The Grit Index,'" says Suzanne Boas, president of
Consumer Credit Counseling Service of Atlanta (CCSA). "What kind of
determination do they have? There is a different internal motivator
for people who are successful at repaying their debt." If no one
has refined the Grit Index the way Fair, Isaac handles credit
scoring, there is a wide scattering of data, plenty of
impressionistic material, and a whole world of experienced
marketing people who are now trying to understand delinquent
debtors. The National Foundation for Consumer Credit gathers a
snapshot of data about everyone who seeks credit advice from its
affiliates each year.

All credit-counselling clients are delinquent debtors. But they
are a self-selecting group, those who have taken the initiative to
see if they can find a way out of their thicket of bills.

Of that group, 52 percent reported in 1997 that the reason for
their delinquency was simply "poor money management." Another 40
percent say a "life event" propelled them into debt: about 23
percent attributed their financial problems to unemployment or
reduced income, 10 percent to a change in marital status-divorce or
separation-and 7 percent to medical problems. Those numbers have
remained stable within a percentage point or two for the past five
years.

On the other hand, in the experience of collection company CFS,
80 percent of their customers say they have fallen into financial
trouble because of a life event, double the counseling agency's
average, according to Learned. There are other differences between
the self-selectors and the rest. The average debt of someone
seeking help from a counseling service is more than $20,000. At
ContiAsset, the average debt is only about $1,500; at CFS it's
$3,700.

Part of the difference between self-selectors and the average
debtor is where they come from. Counseling services essentially
take all comers. In 1997, almost 11 percent of NFCC's customers
reported annual incomes of more than $50,000, and one out of six
identified their work as professional, technical, or managerial.
But most counseling clients skew toward the lower end of the income
scale; the average household income for those seeking counseling
clients in 1997 was $28,661, more than 15 percent below the
national average household income. Although charged-off credit card
debt, too, comes from all socioeconomic levels, most of the debt
that companies like CFS buys is A-rated credit card debt-that is,
the credit card holders who have stopped paying their bills were,
at one time, considered the best risk among consumer borrowers.

West Capital Financial Services, a San Diego company, works much
the way CFS does, buying high-quality, charged-off credit-card
debt, then trying to work with debtors politely to get all or part
of it paid. "Our experience shows us that of the people we deal
with, only a small percentage will tell us to take a hike-10 to 15
percent, perhaps," says West Capital president and chairman Carl
Gregory.

West Capital, too, knows what it doesn't know, and it is using
the work of a Ph.D. statistician, hired as a consultant last
spring, to refine the way it approaches customers. The statistician
is working through data from West Capital's 3 million customers,
looking for patterns among triggering events, among demographic
data, and doing pure statistical analysis, to discover connections
that the company might not otherwise think of.

Gregory says these efforts should improve not only his
collectors' efficiency, but their effectiveness, as well. "As a
result of all that'sgoing on, we believe we will get more money
from certain accounts and require fe wer people to collect from
others." Gregory, like others in the collection arena, wouldn't be
specific about what kinds of connections between demographic data
and likelihood of payment his company is discovering. But only a
few months into the analytical effort, he says, "We use the results
with decisions about who to call, and it is becoming more
suggestive of what approach [with a customer] would be most
successful."

Perhaps most surprising is that West Capital's statistician
hasn't discovered any previous research of significance on
delinquent debtors. "It's pretty astounding that there's all this
debt out there, but there is not a lot of data," says Gregory.

West Capital is also working on a partnership with an outside
data firm to see what value there is in matching its files against
commercially available data on households and individuals. Although
other kinds of companies have long used demographic data to better
understand their clients (and although financial services firms use
such information to solicit credit customers), using such data to
understand delinquent debtors is still in its infancy. Only now are
financial institutions learning to use data-mining techniques that
are commonplace in other businesses.

Most collection companies, including ContiAsset, CFS, and West
Capital, do use analytical models to score the debt they are buying
before they buy it; that, in part, is how they decide how much to
pay for it. But those models rely on the scant information found in
the delinquent debt file itself: Is there a current address,
current phone number, social security number? when was the last
payment? how big is the debt, and how old?

"From the banks," says Learned of CFS, "we get almost nothing in
the way of information. We know where [the debtors] live, perhaps a
bit of collection history. We can usually deduce their gender."

Still, over time, Learned says, CFS has learned a lot about its
customers. Only 60 percent of the credit files it buys, for
instance, have accurate contact information. About 7 percent of the
people CFS inherits go bankrupt.

"Another small group," says Learned, "perhaps 10 percent or so,
never intended to pay the money back the moment they spent it. They
are kind of a casual crook-someone, say, a college student, who
gets offered a card and says, 'I'm going to max this out. What can
they do to me?'"

The largest group, perhaps 80 percent, says Learned, "are people
who have gone through some life-changing event, something that many
times is beyond their control. But in the long-term, they want to
pay." Those are the defaulters Learned wants to understand
better.

Veteran debt collectors know intuitively that more information
will change the collection process. "If we know that the debt we
are buying is all VISA gold cards instead of regular VISA cards,
that makes a difference," says Gary Wood, who buys consumer debt
for Collins Financial Services in Austin. "Gold cards are typically
only offered to people who meet some demographic and credit
requirements, in excess of the basic card. So instead of collecting
10 percent of the debt, we might expect to collect 15 percent. It's
a flag. If we knew that half the accounts were people with a
college education, that would be helpful to us. If we could find
out that the person owns his own home, that's a big bit of
information to get hold of. Homeowners tend to be more responsible
in taking care of their debt."

Although Trajecta won't talk about the specifics of the work it
is doing, the modeling company has come to some of the same
conclusions as Wood. "We know some things do matter," says Harris.
"Things that indicate basic stability in life typically indicate a
person will be okay on their debt." So snippets like how long a
person has been at their address, how long they have had their
checking account at the same bank, whether they own their home, how
many times they've moved-if available, can help predict collection
success or failure.

Trajecta has discovered that delinquents do look different in
one area of their credit files: "Delinquents," says Mac McCarty,
"tend to have fewer active credit lines"-than either good customers
or those going bankrupt. "The average number of accounts opened by
delinquent debtors is roughly half that of good or bankrupt account
holders."

And Harris says an emerging area of study involves relating what
people actually bought with their credit cards to whether they'll
pay their bills. "If you've got someone using credit cards for
gambling, that's an indicator that you're dealing with a real
dangerous person."

When psychologist John Bachman arrived at CFS from California
last summer, his starting place was a file of letters from CFS
customers-500 thank-you notes from people happy with their
"collection experience."

Bachman is using that batch of happy customers to begin his
research into how CFS clients got into debt and what motivated them
to get out. "My ultimate goal is to develop an algorithm from which
I can predict payment behavior based on history," he says.
Bachman's preliminary work already sounds different than the kind
of scoring credit card companies do, although it betrays a faint
echo of a much earlier era, when bankers knew their customers
personally.

"As a psychologist," says Bachman, "I'm interested in looking at
personality characteristics as underlying motivation." So he is
thinking about psychological categories such as "competitive
consumers," people who buy to maintain a lifestyle similar to their
peers and whose overspending comes from an aggressive, competitive
personality. Another classification he calls "compulsive
overspenders," people who feel empty inside, hungry, never
satiated, who buy in pursuit of feeling full. And then there are
"codependent spenders," people who buy things to take care of
others, to make them dependent.

Bachman isn't sure how such categories will be useful in
collection. "The question is, if we get a customer who has these
kinds of personality issues, what kind of account officer can we
get to work with this person?"

West Capital's Carl Gregory makes the same point, but from a
different perspective. Although debt collection is an ancient
trade, it is still in many ways a cottage industry, with thousands
of small practitioners. The new focus on understanding delinquents
simply reinvents and technologizes a process common a generation
ago.

"It wasn't that long ago," says Gregory, "that if you wanted to
borrow a thousand bucks, you had to walk into a bank, sit down
across from a guy at a desk, show him your W-2 statement, maybe
your taxes, and he would say yes or no." Often, the yes or no was
based as much on the banker's knowledge of your character-his
intuitive understanding of your demographics, psychographics, and
Grit Index-as on the papers you brought with you.

Today, says Gregory, "when you want $1,000, all you have to do
is open your mail."